Question

You are considering two securities. Security A has a historical average annual return of 7% and a standard deviation of 3%. Security B has a historical average annual return of 7% and a standard deviation of 9%. From this information you can conclude that:

Answer 1

Security B is riskier than Security A.

Explanation:

Security A and B have the same historical average annual return which is 7%, meaning that both of them have had the same results over the years.

However, the standard deviation of A is 3% and the standard deviation of B is 9%, therefore we can conclude that Security A is safer than Security B because a low standard deviation indicates that the annual returns tend to be close to the average (mean), while a high standard deviation indicates that the annual returns are spread out over a wider range of values.

For example:

Security A has this values over the years:

6, 7, 8, 7 where mean is 7.

Security B has this values over the years:

1, 13, 4, 12 where the mean is also 7.

But, A has a lower standard deviation and B a higher one, therefore, Security B is riskier.